Private consumption holds the key to growth at a time of slowing exports—so how can Japan’s policymakers create incentives for consumers to spend? The Bank of Japan actually may already be doing that, by both lowering borrowing costs and reducing the government’s debt burden.
Over the past decade, there is an increasing sense among Japan’s policymakers that growth must be stimulated and deflation countered. Arguably, the most spectacular of these measures has been aggressive monetary easing, especially the use of negative interest rates this year.1 The verdict on some of these policies is mixed from a broad macroeconomic perspective. However, various components of the economy might throw pleasant surprises. Private consumption, which holds the key to growth at a time of slowing exports, is one such example. While consumers obliged by increasing spending in Q1, they face strong headwinds in the medium to long term from an aging and declining workforce. So how can Japan’s policymakers create incentives for consumers to spend? The Bank of Japan (BOJ) actually may already be doing that, not just by lowering borrowing costs but also by reducing the government’s debt burden.
It’s likely that the impact of aggressive monetary easing on the Japanese yen has run its course.
The economy grew at a seasonally adjusted annual rate (SAAR) of 1.9 percent in Q1, reversing from a 1.8 percent decline in Q4 2015 (figure 1). This was the second estimate for Q1, up from the 1.7 percent rise quoted in the first estimate. Private consumption (2.6 percent) was a key growth driver in Q1, with households spending more, especially on durable goods and services. Investments continued to disappoint, with both private residential and nonresidential investments declining during the quarter. A deeper look at business investment reveals that spending on buildings and structures as well on machinery and equipment has been weak for the past year. This is not an encouraging sign for an economy eager to ramp up productivity in the face of disadvantageous demographics. Exports provided much-needed succor to the economy in Q1, expanding 2.4 percent. However, the pace is lower than what Japan’s policymakers would want. It’s likely that the impact of aggressive monetary easing on the Japanese yen has run its course.
Analysis of national accounts data reveals that while compensation of employees—both nominal and real—has gone up in the past year (figure 2), the share of household spending in GDP has continued to decline (figure 3). This seems surprising, given a strong labor market—unemployment is at a two-decade low—and real income gains due to low inflation. Japan’s low inflation, however, is due to deflationary pressures. So instead of spending more, consumers have held back, waiting for prices to stabilize. Moreover, as economic growth fluctuates, households appear pessimistic, with consumer confidence still in negative territory.2
Private consumption faces a deeper problem: deteriorating demographics. In the last 10 years, Japan’s population has fallen 0.6 percent, and its labor force, 0.7 percent (down 2.7 percent since 1996). This means that the number of earning individuals has declined. The burden of supporting welfare now rests on a shrinking workforce. Japan is also aging fast, which is evident in the composition of its labor force (figure 4). So a rising share of the labor force has to focus more on savings for retirement than on current spending. (See the sidebar “Interview with Nobuhiro Hemmi” for more insights on this.)
The BOJ, through its quantitative easing (QE) program, has eased the government’s debt burden—about 240 percent of GDP—by reducing the share of publicly held debt.3 For example, between January 2013 and May 2016, the BOJ’s holdings of government debt shot up 212.3 percent, while government debt increased just 12.1 percent. Consequently, the BOJ’s share in total government debt has increased at the expense of others (figure 5). How does this help as total debt has not gone down? The BOJ now can easily convert this debt to perpetual-zero coupon bonds or, in the worst case, wipe it off its own balance sheet. Will this not increase risks and push yields up? Not really, because the level of publicly held debt has gone down due to the BOJ’s rising share and hence has become more manageable. Moreover, the BOJ’s ultra-loose monetary policy and global financial volatility have driven borrowing costs to extremely low levels (figure 6).4 Interestingly, the government has more leeway now to introduce fiscal stimulus without spooking markets about rising debt.
The BOJ’s QE program aids consumers by making publicly held debt more manageable, allowing the government more time to service that debt, in turn allowing consumers some breathing space. For example, it is possible that the second part of the two-part sales tax (first introduced in 2014) may be pushed beyond the revised date of 2017. Also, with a declining and aging population, the government may be hoping to partially shelter its working population—those who pay taxes and contribute to social welfare—from the burden of rising debt. In addition, the BOJ’s move could help in the fight against deflation. This argument probably runs counter to examples in Venezuela, Argentina, and Zimbabwe, where monetizing the government’s debt has led to hyperinflation. Japan, however, need not to worry about that. Increasing consumption through reducing the debt burden might just help ease excess capacity in the country, thereby reducing deflationary pressures, which, in turn, might benefit Japanese companies who are likely to face increasing headwinds from slowing global growth. The BOJ and the government must be hoping the plan works, bringing much-needed respite for the economy.
To understand more about recent policies and challenges ahead, I spoke with Nobuhiro Hemmi, partner and head of Global Business Intelligence at Deloitte Tohmatsu Consulting, Japan, and a member of the Deloitte Global Economist Council.
Akrur Barua (AB): The BOJ decided to keep rates on hold. Is it because BOJ thinks that monetary policy is not effective anymore? Or is it because the external environment is challenging, and the BOJ wants to wait and watch?
Nobuhiro Hemmi (NH): Both, I think. Officially, they seem to have announced a “wait and watch” policy as is evident from the BOJ governor’s interview.5 However, they introduced negative interest rates, which is not traditional monetary policy. This sort of contradiction reflects the new challenges that the BOJ faces.
AB: We have seen fiscal stimulus and strong monetary easing. The initial results were good, but they appear to be faltering now. When is the “third arrow” of Abenomics coming? What are the challenges? Which reforms do you think they should target?
NH: The market appears to have overestimated the impact of the “third arrow,” which has been the fundamental issue for Japan in the last two decades. So far, discussions around the “third arrow” have focused on growth strategies and easing regulations. However, the key issue is how to tackle the decrease in working population.
AB: The yen’s rise is opposite to what Japanese policymakers would want. How are exporters coping? Where do they see additional demand coming from? And which economies do they think will be the big markets over the next 5–10 years?
NH: Overall, from a macroeconomic point of view, the yen’s rise seems opposite to what policymakers would want. However, the impact (and implication) depends on industries and companies within these industries. Some companies have already shifted their operations outside of Japan, and others have hedged currency risk in the short term. Asia will still be a strong market for Japanese companies in the next 5–10 years. But there will be market segmentation, with a shift to a city-based approach from a country-based one.
AB: To stimulate domestic demand, Japanese corporates should invest more. Why have investments not picked up?
NH: If domestic demand is not positive in the near future, it will make sense for Japanese companies to be more conservative.
AB: With an aging society, what changes do you see in the next 5–10 years that will prop up domestic demand? More immigration or higher wages? Or longer working tenures?
NH: More than immigration, women’s participation in the labor market is an important issue for Japan. If policymakers cannot successfully implement a “womenomics” policy, they will introduce a further extension of the retirement age. Wages and tenures are not the key issues right now.